Raising Credit Ratings for Top Cruise Lines

Wayne Stefurak: Morningstar Credit Ratings raised the ratings on seven issuers in the consumer cyclical sector during the first quarter of this year, including two cruise lines. Carnival Corp. was upgraded to BBB+, and Royal Caribbean was upgraded to BBB-, among the first investment grade ratings for the company. Meanwhile, MCR affirmed Norwegian Cruise's rating at BB.

These three issuers constitute the largest companies in the industry, collectively holding an approximate 80% share of the market. The global cruise line industry carried 24 million guests in 2016, with Carnival serving nearly have of these customers, followed by Royal with a 24% share, and Norwegian at 10%. These dominant market positions, coupled with substantial capital investments needed to enter the market, create efficient scale in the industry, one of Morningstar's economic moat sources.

In addition, this oligopoly is amicable, with pricing supported by rational competition. MCR believes a favorable balance between growing demand and the supply of new ships will support firm pricing.

On the supply side, shipyards are full, and therefore annual capacity growth is expected to be limited to about 4% through the end of the decade. In terms of demand, the U.S. market remains the largest, and is still underpenetrated, with only about 25% of the population ever taking a cruise, while the baby boomer demographic will drive future growth.

Recent rating actions also reflect substantial operating improvements. Over the past three years, Carnival, Royal, and Norwegian significantly expanded adjusted EBITDA margins. Also credit metrics improved, as evidenced by substantial debt leverage reduction.

A stable outlook on all three issuers reflects an expectation that each will remain committed to their balance sheet strength.